if China signaled a change of heart either
because it feared taking big losses on its hold-
ings of Treasury bonds or because it decided
that the Chinese economy had reached the
level of diversification to make do without
for the exits.
the Persian Gulf, might decide to use our fi-
nancial dependence for strategic advantage.
ranks of the financial superpowers, figuring
the political gains were worth the costs of
losses on its bond holdings and temporary
disruption in its export markets.
vorite: In 400 BC, Dionysius of Syracuse (a
cally irresponsible. He liked parties, gold and
palaces (not to mention costly military ad-
ventures), and eventually found himself un-
able to pay his debts. He commanded his citi-
zens, on pain of death, to turn in their
one-drachma coins. He then stamped them
as two-drachma coins and repaid citizens
with the debased currency. Other profligate
rulers achieved similar ends by shaving metal
from the edges of coins or by diluting gold
with base metals in order to expand the
found that, through history, expanding the
money supply ("monetizing the debt") was
the favored response to a debt crisis. There
are less crude ways of doing this than the
method chosen by Dionysius. And while the
ingly give up its ability to contain the money
ity, it might not have a choice.
the Federal Reserve System since they hold
their reserves in Treasury securities. So default
would very likely cause a systemic financial
market collapse. Ironically, the "riskless asset,"
rather than subprime mortgages or other
high-risk investments, would be the culprit.
government creditors, the cost of the result-
ing inflation should not underestimated. All
owners of assets that paid returns in fixed
amounts of dollars (including all U.S. finan-
cial institutions) would experience a decline
in wealth. Indeed, financial institutions would
suffer much greater losses than in the 2008 fi-
nancial crisis, and the insolvent federal gov-
ernment would be powerless to help them.
sumption, compounding the recessionary
impact of the tax increases and spending cuts
that would be necessary to cope with the bud-
justments for inflation, many firms would
suffer huge losses and many would fail. More
generally, the economy would become far less
efficient at delivering the goods and services
that people value most because the price sig-
nals that drive resource allocation would lose
borrowing would become impossible or pro-
hibitively expensive. Washington would thus
suddenly need to start paying bills upfront.